Financial turmoil engulfs Italy amid political uncertainty

Financial markets in Italy have plunged amid fears that the eurozone's third-largest economy is heading towards another election that could shape up to be a referendum on whether to stay in the euro.

Premier-designate Carlo Cottarelli, a former IMF official, is expected to submit his list of ministers to President Sergio Mattarella in Rome, two days after an attempt by two populist parties to form a government failed over the president's rejection of their anti-euro economy minister.

President Sergio Mattarella

Enraged at losing their chance at governing following inconclusive elections in March, both the anti-establishment 5-Star Movement and the anti-euro League vowed with other parties to vote against a Cottarelli government when it faces a vote of confidence in parliament, expected later this week.

That would force Italy to new elections in the autumn, with Mr Cottarelli heading an interim, caretaker government.

"Italy will be wrapped in a long drawn-out period of wrangling that will feature intense anti-establishment and eurosceptic tones," said political analyst Wolfango Piccoli.

He said that while it was doubtful that the 5-Stars and League would "embrace a clear euro-exit platform", they can be expected to be more hostile toward the EU.

The Milan stock index was down nearly 3%, weighing particularly hard on banks, and Italian bonds suffered a plunge reminiscent of the worst days of the financial crisis of 2011.

The government's borrowing rate for two-year money more than doubled, by over 1.5 percentage points to 2.4%, indicating a surge in investor concern. The 10-year yield rose above 3%, according to FactSet.

"We should now call this a crisis," said Kit Juckes, an analyst at Societe Generale.

Ratings agency Moody's warned that it would cut Italy's rating - now just two notches above junk level - if the next government does not present a budget that puts Italy on a trajectory to reduce its debt, now at 132% of GDP, the second highest rate in the eurozone after Greece.

If Mr Cottarelli does not pass a vote of confidence, as is nearly certain, his government would not get a chance to set out such a budget.

In an annual speech on the state of the Italian economy, Bank of Italy governor Ignazio Visco tried to sound a warning against the tide of populism, saying that "Italy's destiny is that of Europe".

"We are part of a very large and deeply integrated economic area, whose development determines that of Italy and at the same time depends on it," he said.

"It is important Italy has an authoritative voice in forums where the future of the European Union is decided," Mr Visco said, referring to upcoming EU decisions regarding the governance of the bloc, multi-year budgets and the revision of financial rules.